The current Operation Twist is scheduled to be terminated at the end of June, which renders the 20 June FOMC meeting an obvious candidate for QE3. The chance of this happening has risen lately following the weak PMIs out of Europe and the slowdown in Chinese growth, which seems to be hurting the US manufacturing sector. On top of this, minutes from the April FOMC meeting were slightly more dovish, as the number of members indicating that “additional monetary policy accommodation could be necessary if the economic recovery lost momentum or the downside risks to the forecast became
great enough” rose to “several” from “a couple”.
That said, as stated in the minutes, the FOMC needs to see a loss of momentum in growth in order to support more QE and this has not materialised in domestic data so far. This was also confirmed by comments from Dudley, the President of the New York Fed, yesterday. Over the past couple of months US data have been mixed but generally point to a continued moderate recovery (see Research US: Don't write off the US economy, 22 May 2012).
Fed’s primary focus is the state of the labour market and the May employment report released on 1 June will be key. The March and April reports showed a deceleration in job growth and if this continues, the pace of employment growth will be below what the Fed sees as consistent with its mandate. If we get another weak employment report, it would,
in our view, tilt the balance in favour of another round of QE. This is however not our expectation, as other indicators such as initial jobless claims and the NFIB survey are pointing to a continued healing of the labour market.
Another trigger of QE3 is financial stress. Although the European crisis has pushed market stress upwards, we are still far from the levels seen in H2 last year. Also worth keeping in mind is the reasoning behind the decision about QE2 in September last year. The FOMC minutes show that the primary reason for the decision to implement Operation Twist was the deterioration in economic growth momentum and not the stress in financial markets. We thus think that stress levels need to go markedly higher before the Fed will act, as long as economic data continue to confirm an ongoing economic upswing. 
Sterilized Bond Buying A Strong QE3 Candidate
Given our expectations of a rebound in private job growth in May, we currently see only a 25% chance of further Fed easing at the 20 June meeting. However (if we are proven wrong), there was an interesting article in WSJ in March, describing possible tools for further monetary policy easing. If another round of easing is deemed necessary, it is likely to be in the form of sterilized bond buying, i.e. the Fed buys longer-dated MBS or Treasuries and withdraws the extra liquidity generated by this transaction via reverse repos or term deposits. This would favour those in the FOMC who worry about the inflationary effect of the expansion of Fed’s balance sheet and increase in the money base.
rview | May 24, 2012 02:20PM GMT | Add a Comment
Danske Markets
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- We believe deteriorating PMIs could trigger a move from the ECB. We now expect the ECB to lower interest rates at the June meeting. We expect a one-off rate cut of 25bp – leaving the refi rate at 0.75%. Deposit rates are likely to be left unchanged while the marginal lending rate is expected to be lowered 50bp to 1.25%.
- If market sentiment worsens on Greek or Spanish concerns, this could trigger additional non-standard measures such as longer maturity LTROs. This is not our main scenario though as we continue to expect a viable solution in Greece.
- The euro area composite PMI dropped from 46.7 in April to 45.9 in May driven by a drop in manufacturing PMI. The German Ifo also gave in and dropped in May.
PMI & IFO
Details And Outlook
The euro area composite PMI dropped from 46.7 in April to 45.9 in May driven by a drop in manufacturing PMI. The German Ifo also gave in. Ifo expectations dropped from 102.7 in April to 100.9 in May. The Ifo current situation dropped from 117.5 to 113.3.
Euro area flash manufacturing PMI dropped from 45.9 in April to 45.0 in May. The new orders components also decreased. Manufacturing new orders dropped from 43.5 to 42.5 and new exports declined from 46.2 to 45.3. Confidence in the service sector decreased from 46.9 to 46.5. Overall, these numbers are much worse than our and consensus expectations.
Manufacturing PMI & IFO Current Conditions
The deteriorating PMIs should, in our view, trigger a move from the ECB. We now expect the ECB to lower interest rates at the June meeting. We expect a one-off rate cut of 25bp – leaving the refi rate at 0.75%. Deposit rates are likely to be left unchanged while the marginal lending rate is expected to be lowered 50bp to 1.25%. If market sentiment
worsens on Greek or Spanish concerns, this could trigger additional non-standard measures such as longer maturity LTROs. This is not our main scenario though as we continue to expect a viable solution in Greece.
Of particular concern is that the core countries are giving in. German flash manufacturing PMI decreased again in May to 45.0 (consensus 47.0) from 46.2 in April. Confidence in the service sector was unchanged at 52.2 (consensus 52.0). Manufacturing new orders dropped from 44.9 to 43.6 and export orders decreased from 43.3 to 43.0. This is not good – especially taking into account the poor Chinese figures released overnight. French flash manufacturing PMI decreased from 46.9 in April to 44.4 in May (consensus 47.0). Service PMI dropped to 45.2 (consensus 45.7). Manufacturing new orders decreased from 43.5 to 41.5 while new export orders decreased from 49.1 to 46.8. The new order inventory balance also declined.
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